Redcentric plc's (LON:RCN) price-to-earnings (or "P/E") ratio of 27.3x might make it look like a strong sell right now compared to the market in the United Kingdom, where around half of the companies have P/E ratios below 13x and even P/E's below 7x are quite common. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's so lofty.

While the market has experienced earnings growth lately, Redcentric's earnings have gone into reverse gear, which is not great. It might be that many expect the dour earnings performance to recover substantially, which has kept the P/E from collapsing. If not, then existing shareholders may be extremely nervous about the viability of the share price.

View our latest analysis for Redcentric

If you'd like to see what analysts are forecasting going forward, you should check out our free report on Redcentric.

Does Growth Match The High P/E?

There's an inherent assumption that a company should far outperform the market for P/E ratios like Redcentric's to be considered reasonable.

Retrospectively, the last year delivered a frustrating 26% decrease to the company's bottom line. At least EPS has managed not to go completely backwards from three years ago in aggregate, thanks to the earlier period of growth. Accordingly, shareholders probably wouldn't have been overly satisfied with the unstable medium-term growth rates.

Looking ahead now, EPS is anticipated to slump, contracting by 75% during the coming year according to the only analyst following the company. With the market predicted to deliver 9.9% growth , that's a disappointing outcome.

In light of this, it's alarming that Redcentric's P/E sits above the majority of other companies. Apparently many investors in the company reject the analyst cohort's pessimism and aren't willing to let go of their stock at any price. There's a very good chance these shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with the negative growth outlook.

What We Can Learn From Redcentric's P/E?

Using the price-to-earnings ratio alone to determine if you should sell your stock isn't sensible, however it can be a practical guide to the company's future prospects.

We've established that Redcentric currently trades on a much higher than expected P/E for a company whose earnings are forecast to decline. Right now we are increasingly uncomfortable with the high P/E as the predicted future earnings are highly unlikely to support such positive sentiment for long. This places shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

And what about other risks? Every company has them, and we've spotted 1 warning sign for Redcentric you should know about.

It's important to make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20x).

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.

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